How to Check if Re-Financing Today Will Save or Cost You Money
Depending on your current interest rate, you may be thinking of looking into a re-finance to take advantage of today’s low rates. Of course, as you probably know it isn’t just as easy as switching your mortgage out for a lower rate, there are several costs and factors you need to consider. Things such as penalty to break your mortgage and closing costs on a new mortgage are all determining factors in the decision to re-finance or not. We’re going to show you how to break down the costs and make an educated decision. Of course, the below is only to give you a guideline and although fairly accurate, should not be used as a quote or promise of any kind. (Seems obvious but we have to write that, you’d be surprised). Now that the legal mumbo-jumbo is out of the way, here’s what you do:
Step 1:
Determine what your penalty is. Unless your mortgage is open, then there will be a penalty to pay it off early. If your mortgage is a variable rate, then you will be paying 3 months interest only which is a simple calculation.
Mortgage Balance x Interest Rate = A
A ÷ 12 = B
B x 3 = 3 months interest penalty.
- $300,000 balance at 2.30% (300k x 2.30% = $6,900. $6,900 ÷ 12 = $575 x 3 months = $1,725
If you are on a fixed rate then your penalty will be the greater of three months interest (above) or Interest Rate Differential (IRD). IRD is where the lender takes your current rate and puts it against the rate being offered for the term that most closely matches the time remaining on your mortgage term. So if you have 2 years left on your mortgage, they would use the 2 year term. The math for this is slightly more complicated.
Current Rate – Reinvestment Rate = A
Mortgage Balance x A = B
B ÷ 365 x Number of days left to maturity = IRD Penalty.
Let’s see an example using a mortgage balance of $300,000 with an interest rate of 3.19% with 2 years left on the term and a current 2 year rate of 2.29%. Remember, these numbers are for example purposes only.
Ex. 3.19% – 2.29% = 0.90%. $300,000 x 0.90% = $2,700 ÷ 365 x 730 = $5,399.81 IRD penalty
You can also take into consideration your pre-payment privileges on the balance.
So now that you are able to calculate your penalty all on your own, let’s move to step two
Step 2:
Get an estimate of any closing costs you are likely to incur. For this example we will use the IRD results from above and assume our mortgage balance is $300,000 at 3.19%, we will also estimate the following:
Appraisal cost: $350
Legal Fees: $1,500
Penalty using IRD method: $5,399.81
Total: $7,249.81
Step 3:
Now that you know what it will cost you to break your mortgage and close a new one, it’s time to determine your potential savings on a new mortgage. Again, we will assume our balance is $300,000 with our current interest rate at 3.19% and our potential new rate being 2.64%.
Over the last two years remaining on your term, you would be paying roughly $16,500 of interest at the 3.19%
and on the first two years of your new mortgage at 2.64% you would be paying about $14,500 of interest, a savings of around $2,000. Or you can look at your existing payments of $1,449.14/month vs your new payments of $1,364.90 a savings of $84.24/month. Over two years $2,021.76. This of course does not outweigh the cost of breaking the mortgage and would therefore be better to wait until your penalty is lower. In the case where you are paying three months interest, then it would be worth it to re-finance.
Keep in mind you should always double check with your mortgage broker to be sure what the penalty is. In a lot of cases, they may be able to get you a discount on the penalty or help you avoid legal fees and appraisals costs. If you are thinking about re-financing to get your rate lowered, check in with us and we’ll let you know where you stand. Hope this helps you understand your mortgage a little better.
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